What does the capital shortfall mean for banking sector?

Bangladesh's banking sector is under mounting stress as the combined capital shortfall of 20 banks surged by Tk1.18 lakh crore in Q4 of 2024, pushing the total deficit to Tk1.72 lakh crore by year-end.

This sharp rise signals growing fragility in the sector, with many banks now struggling to absorb losses, meet regulatory buffers, or retain depositor trust. A prolonged shortfall may lead to credit rating downgrades, liquidity pressures, or even institutional collapse.

Regulators could be forced into tough choices — from imposing restrictions to pursuing recapitalisation or forced mergers.

The Business Standard spoke with leading economists and bankers to unpack the causes, risks, and remedies.

Sketch: TBS

NPLs and minimal provisioning were hidden before

Dr Zahid Hussain

Former Lead Economist, World Bank Dhaka office

The primary reason, in my view, is that NPLs were previously concealed, leading to their understatement. Additionally, the provisioning for the reported NPLs was inadequate. For instance, certain categories — especially those classified as bad loans — require 100% provisioning.

Previously, banks did not provision the full amount, but now they are doing so correctly. This adjustment reduces profit and, consequently, diminishes capital. From an accounting perspective, this is the crux of the issue with no other plausible explanation.

This discrepancy should have been evident in figures all the time, but it was not, particularly in instances where banks declared dividends without sufficient profits, relying solely on reported figures. This resulted in a decrease in capital due to diminished retained earnings.

On the corporate front, corporate governance was historically very weak, especially in banks with political connections. This is the underlying issue. Whether it's under-provisioning, failure to disclose NPLs, or excessive dividend declarations, these are all manifestations of poor corporate governance.

What do we mean by corporate governance in this context? Essentially, it pertains to the responsibilities of the Board of Directors. The board must guarantee that the bank's financial statements — balance sheet, profit and loss statements — are accurate and comply with Bangladeshi regulations.

A bank is managed by key personnel such as the managing director and chief financial officer, supported by the board comprising the chairman, independent directors, sponsor directors, among others. Additionally, the audit committee has the critical role of scrutinising financial statements and posing the necessary inquiries to ensure compliance.

Historically, this protocol was not rigorously adhered to. However, recent times have seen a marked enhancement in regulatory vigilance. If issues flagged by the board reach the regulator, managing the regulator is no longer as straightforward as it once was.

Thus, if we delve into the fundamental cause, it is corporate governance. It is not as though there has been a significant economic upheaval or catastrophe. While events such as floods or political instability have occurred, they do not account for the persistent capital shortfall. Hence, our focus must be on internal factors.

Taking a broader perspective, it appears that conditions were seemingly "better" in the past, primarily because NPLs were concealed, and provisioning was insufficient. The regulations were either disregarded, or loopholes were exploited. Now, the opportunity for such practices has been significantly diminished. They were not better.

So, what do we mean when we say conditions are better now? Improved disclosure and enhanced compliance are two key aspects. However, this doesn't mean that the underlying issues have been resolved completely.

The aim of thorough disclosure is to pave the way for solutions. We might feel somewhat reassured if better information and compliance drove action; unfortunately, we haven't reached that stage yet. Therefore, while compliance and disclosure may have advanced, we are still far from durably solving the capital shortfall issue.

Dr Zahid Hussain spoke to TBS' Nasif Tanjim over the phone.

Sketch: TBS

Some banks increase capital through sufficient profits

Muhammad A (Rumee) Ali

Former Deputy Governor, Bangladesh Bank

Capital adequacy is directly related to the level of classified loans. If bad loans increase, the capital adequacy requirement also rises significantly. This is because banks must make 100% provisions for those loans, which raises the capital required to meet regulatory standards.

So, where does this capital come from? There are only three sources: profits, fresh capital from shareholders, or a new share issue. There are no other options.

Now, I haven't heard of any recent share issues. Similarly, if shareholders had done something, like a rights issue — I haven't heard of that happening either. That suggests the banks that managed to increase their capital did so by generating and retaining sufficient profits. Only those banks could meet the capital adequacy requirements. No one else could.

There's another issue at play. In the past, non-performing loans (NPLs) were often hidden. Now, with stricter compliance and asset quality reviews, some of those hidden loans are being recognised.

Once these are recognised, the provisioning requirement increases. So the question is: Where does a bank make provisions from? Provisions are made from capital, retained profits, or current profits. That's it.

And when a bank makes provisions from these sources, what happens in practice? Capital is reduced because retained profit is part of capital. If capital decreases, it affects capital adequacy.

So yes, recognising previously hidden NPLs has increased the capital requirement. Provisions have been made, but the available capital has become inadequate. That's why there's now an urgent need to increase capital.

Muhammad A (Rumee) Ali spoke to TBS' Nasif Tanjim over the phone.
 

Sketch: TBS

No quick fix for shortfall, needs multiple strategies

Professor Mustafizur Rahman

Distinguished Fellow, Centre for Policy Dialogue (CPD)

The shortfall is mainly due to provisioning. Previously, bad loans could be concealed through data massaging. Now, transparency has been introduced. As a result, provisioning must be made against them. This, in turn, is causing the shortfall.

However, exercising this transparency was necessary anyway. Before, we were sweeping the bad loans under the rug and pretending as if nothing was wrong. It was bound to cause a big problem someday.

It already has. These banks are certainly a burden on the banking sector. They are also having multifaceted impacts on the overall economy. The most significant effect is that, due to provisioning requirements, lending rates have to be kept very high — even higher than the policy rate.

To that extent, it is adverse for investment and job creation. Overall, it poses several challenges to macroeconomic management.

It is a good thing that at least the primary and most important issue has been identified, and the process has been made transparent.

It must be acknowledged that Bangladesh Bank is taking some discrete steps.

Firstly, bringing in transparency, and secondly, establishing accountability through a recovery drive. The recovery drive is being carried out using several strategies — one is by appointing asset recovery companies to handle it, another is by seizing their shares in various places. In the future, there may be attempts at some mergers and acquisitions as well.

However, it is important to note that the deep-rooted problems that have accumulated over the years cannot be solved overnight. There is no quick fix. The shortfall problem needs to be addressed gradually through various strategies.

Professor Mustafizur Rahman spoke to TBS' Ariful Hasan Shuvo over the phone.

Sketch: TBS

Crucial to engage with government to fix bad assets

Syed Mahbubur Rahman

Managing Director and CEO, Mutual Trust Bank

Some banks are facing a shortfall of several thousand crores of taka. It is not an easy job to overcome this just by generating profit.

One possible solution could be bringing in investors, whether local or international, who can inject capital. Besides that, it is crucial to engage with the government to find ways to address the bad assets.

But how that would happen is also a question; will it be done through an asset management company? Even that would require a huge amount of funding, because tens of thousands of crores have been lost.

We talk about Sri Lanka's economy and how it recovered swiftly. One of the key reasons behind this is that their banking sector was very strong. Even though the country defaulted, the banks did not. They had no liquidity crisis and remained in good shape.

In our case, the situation is quite the opposite — while the country has not defaulted, our banking sector is in a fragile state. Bad loans cause interest rates to keep rising. At the end of the day, good customers end up bearing the burden for the faults of others.

The shortfall issue requires much deeper examination and the adoption of innovative measures.

A committee should be formed involving all stakeholders—commercial, central, and multinational bankers. The committee should conduct detailed discussions based on the findings of the forensic audit reports. If we need the support of an international body like the IMF, we must seek it.

Syed Mahbubur Rahman spoke to TBS' Ariful Hasan Shuvo over the phone.